FISCAL POLICIES TO ACCELERATE ECONOMIC GROWTH
INTRODUCTION
Edgardo Favaro February, 26 2004
IN INDIA HIGH RATES OF ECONOMIC GROWTH HAVE CONCURRED WITH HIGH FISCAL DEFICITS FOR TWO DECADES • The average rate of growth of real GDP from 1982 to 2002 was 5.8 percent. In turn, the average ratio of the fiscal deficit of the General Government to GDP was 8.3 percent.
Figure 1: Rate of Economic Grow th and Ratio Fiscal Deficit to GDP 10% 8% 6% 4% 2%
SDEF
GYN
2000-01
1998-99
1996-97
1994-95
1992-93
1990-91
1988-89
1986-87
1984-85
1982-83
1980-81
0%
FIGURE 2:HISTOGRAM OF RATIO FISCAL DEFICIT TO GDP (GENERAL GOVERNMENT) 6
Series: SDEF Sample 1982 2002 Observations 21
5 4 3 2 1 0 0.06
0.07
0.08
0.09
Mean Median Maximum Minimum Std. Dev. Skewness Kurtosis
0.082661 0.085128 0.101000 0.059045 0.013098 -0.235261 1.710307
Jarque-Bera Probability
1.649112 0.438430
0.10
MEASURED IN THIS WAY ARGENTINA OR BRAZIL’S HISTORY OF FISCAL INDISCIPLINE PALES IN COMPARISON. HOWEVER, WITH THE EXCEPTION OF 1991, HIGH FISCAL DEFICITS HAVE NOT SPILLED OVER THE EXCHANGE RATE AND THE BALANCE OF PAYMENTS (AN EXPERIENCE VERY DIFFERENT FROM THAT OF ARGENTINA AND BRAZIL).
THESE STATISTICS RAISE A NUMBER OF QUESTIONS: •
Are high fiscal deficits sustainable, say in the next five years?
• What are the roles of tax revenue enhancing measures and government spending cuts in a deficit reduction strategy? • Why has government spending soared over the past two decades? • Does the quality of government spending matter for economic growth?
Are high fiscal deficits sustainable in the medium term?
FIGURE 3: SHARE OF GENERAL GOVERNMENT DEBT IN THE GDP .76 .72 .68 .64 .60 .56 .52 .48 82
84
86
88
90
92
94
SDEBT2
96
98
00
02
FACTORS EXPLAING SUSTAINABILITY:
B D it DEF D B = + it t −1 = + ( ) Y Y 1 + π ( 1 + g ) Y t Y t t t t Y t −1 t
And, deficit adjusted by inflation measure (ADJDEF) is:
Bt −1 D it − π t ADJDEF D B = + = + rt Y Y Y ( 1 + π )( 1 + g ) t Y t t t t Y t −1 t
πt DEF B = − Y t (1 + π t )(1 + g t ) Y t −1
FIGURE 4: GENERAL GOVERNMENT DEFICIT (DEF) AND DEFICIT ADJUSTED BY INFLATION (DEFADJ) (AS A PERCENTAGE OF GDP) .12 .10 .08 .06 .04 .02 .00 -.02 82
84
86
88
90 DEF
92
94
96
DEFADJ
98
00
02
FIGURE 5: RATIO DEFICIT ADJUSTED BY INFLATION TO GDP AND RATE OF INFLATION .16 .12
.08 .04
.00
-.04 82
84
86
88
90
92
DEFADJ
94
96 PI
98
00
02
FINANCIAL REPRESSION HAS KEPT DOMESTIC INTEREST RATES BELOW THE OPPORTUNITY COST OF CREDIT IN THE INTERNATIONAL MARKET For instance‌.with the exception of the early 1990s, the India Government consistently borrowed at a cheaper rate than the US Government for the past thirty years. [1] , [2] FIGURE 6: COST OF PUBLIC DEBT IN INDIA AND THE USA 0.18 0.16 0.14 0.12 0.10 0.08 0.06 0.04 70
75
80
USINTE18
85
90
MTYIELD
95
00
IGOBB
___________________________ [1] The illustration is based on a comparison between an 18 years moving average of the yield on Indian 10 year Treasury bills arbitraged to dollar (MTYIELD) and an 18 years moving average of US Government 10 year Treasury bills. [2] In addition, steady inflation and high monetization have also had a positive fiscal effect through the creation of revenue from seignorage.
SEVERAL CONCLUSIONS: 1.
India’s ability to sustain high fiscal deficits depends on the capacity of the public sector to continue borrowing at lower than international rates and on keeping domestic inflation continuously above international levels.
2.
If the Government of India opens up financially to the rest of the world, as it has been announcing for several years, it will have to bear the cost of higher interest rates.
SEVERAL CONCLUSIONS (CONT’D): 3.
The fall in inflation after 1998 implies the loss of an important source of revenue.
4.
This source of revenue has not been yet replaced by an increase in more conventional sources of tax revenue.
5.
A call for fiscal caution is well founded. Inflation and financial repression cannot be the mechanism to maintain ‘control’ of India’s public finances.
SEVERAL CONCLUSIONS (CONT’D):
6.
At this moment the fiscal and monetary policy combination is not sustainable. However, a balance of payment crisis is very unlikely.
7.
Persistence of fiscal deficits at the current rate (average of the past three years) will most likely result in an increase in money-income velocity and average inflation.
SEVERAL CONCLUSIONS (CONT’D):
8.
Alternatively, accepting a permanent fall in revenue from inflation (and an increase in government borrowing costs) will have to be offset by a permanent increase in revenue from alternative sources.
9.
Reducing government spending as a proportion of GDP in India is probably not an alternative for a public sector that is highly indebted and needs to spend heavily in improving the level of human capital and basic infrastructure.
WHAT IS NEEDED IN INDIA IS PERHAPS: •
a medium-term strategy, spread over a 3-5 year horizon, focusing on not only reversing the downward trend in the revenue-to-GDP ratio observed during the 1990s but increasing the ratio, and
• a deep restructuring of expenditure with a pronounced shift in emphasis from current to capital expenditure.